The London Interbank Offered Rate (LIBOR), the interest rate tied to trillions of dollars in loans and other financial products, will be eliminated by the end of 2021. British regulators announced the timeline on Thursday, July 27, to allow for the phase-in of new benchmark rates. U.S. and international regulators are developing replacement benchmark rates and are expected to outline implementation plans later this year.
What does this mean for lenders?
- Loan originators and swap providers should evaluate non-LIBOR indexes for new loans maturing after 2021.
- For new LIBOR-based loans or swaps maturing prior to 2021, other reference rates should be identified for use as a substitute index.
- Personnel responsible for loan administration and compliance should closely monitor implementation guidelines produced by regulators.
- Loan documents for new LIBOR-based loans should specify an alternative index or expressly permit the lender to select a comparable reference rate when LIBOR is eliminated. Procedures for implementing a new index for LIBOR-based loans should be clearly stated.
- Loan documentation for existing LIBOR-based loans should be reviewed to determine the lender’s ability to select an alternative index when LIBOR is eliminated. If the documents fail to expressly state an alternative, an amendment may be necessary.
LIBOR Use and Reliability
LIBOR is used to calculate interest rates for numerous types of debt obligations, including personal and commercial loans, interest rate swaps and other derivative products, making it a primary metric in the global banking system. LIBOR is set every business day in numerous currencies and maturities, based on estimates submitted by major banks. In the wake of the financial crisis, several banks were discovered to have doctored estimates in order to manipulate LIBOR, prompting a push for submissions based on actual interbank loans. But according to the U.K. Financial Conduct Authority (FCA), the interbank lending market slowed in recent years, resulting in a lack of data on which to base LIBOR estimates and therefore susceptible to further fraud. The FCA determined that without an active market to support estimates, LIBOR should not be used as a benchmark rate.
In anticipation of the elimination of LIBOR, the U.S. Federal Reserve established the Alternative Reference Rates Committee (ARRC) to select a replacement index for U.S. Dollar LIBOR. ARRC, comprised of a group of large domestic banks and regulators, voted to use a benchmark based on short-term loans backed by Treasury securities, known as repurchase agreements or "repo" trades. ARRC is expected to announce a transition plan for the new rate later this year. The Bank of England has proposed replacing GBP LIBOR with an index based on short-term loans tied to the pound, and the European Money Markets Institute will identify a replacement rate for the Euro LIBOR.